After a Decline, Utilities Brighten

By

Andrew Bary

June 16, 2013

After a 10% drop since late April, electric-utility stocks are looking attractive.

The group has been hurt by a rise of one-half percentage point in Treasury bond yields and concerns that rates may be headed still higher. Other rate-sensitive sectors of the stock market also have been hit, including real-estate investment trusts.

Utility boosters point to dividend yields that now average 4%, plus slow but relatively predictable profit growth of 4% to 5% annually over the next few years.
Credit Suisse
analyst Dan Eggers recently wrote that utilities offer the prospect of a "high single-digit annual return in a low-risk package."

Revenue and profit growth in the coming years likely will be driven by investments in new generating plants and upgrades to the country's aging electricity transmission network.

ENLARGE

One fan of the sector is
Warren Buffett
,
the CEO of Berkshire Hathaway. Berkshire's MidAmerican utility division recently agreed to buy NV Energy, a Nevada electric company, for $23.75 a share, or $5.6 billion. That price translates into a price/earnings multiple of more than 18 times projected 2013 profits.

A diversified way to get exposure to the group is through the Utilities Select Sector SPDR , the largest utility exchange-traded fund. This ETF trades around $38, yields about 3.5% and contains the largest electric utilities in the Standard & Poor's 500-stock index, led by Duke,
Southern
Co.
, and
Next Era Energy
.

Mr. Eggers prefers utilities dominated by regulated businesses rather than "hybrids" that have large unregulated power operations. The unregulated business can be volatile and has been hurt by low power prices. "There's more durable earnings growth and lower risk" with the regulated companies, Mr. Eggers says.

The appeal of Virginia-based Dominion comes from above-average growth in power demand in its territory, a large project to upgrade transmission lines and generally favorable regulation. Shares, in the mid-$50s, yield 4.1% and trade for 16 times projected 2013 earnings.

Southern used to be considered the blue-chip utility stock. That status has been eroded due, in part, to higher-than-expected costs at new plants. Having lagged behind the group in the past year, Southern is looking better. At around $44, the shares yield 4.6% and trade for 16 times estimated 2013 earnings.

Investors likely won't make a killing with utilities. But the stocks are relatively safe, carry nice yields and could generate reasonable growth in profits—and dividends—in the next several years.

—Andrew Baryis associate editor for Barron's. For more stories, see barrons.com.

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